For those in the know, alternative finance has been one of the big stories of the past five years. On the principle that even the darkest and most turbulent clouds somewhere conceal a silver lining, the financial crisis of the late 2000s paved the way for a wave of innovation that saw the arrival of new online platforms offering businesses an alternative to traditional bank and equity investment. Since then, increasing numbers of businesses have been exploring various flavours of peer-to-peer lending and crowdfunding.
That’s the headline story. But in reality, overall awareness of alternative finance is still relatively low. Last year, a study sponsored by the Federation of Small Businesses and the British Chambers of Commerce found that 80% of funding to small and medium sized businesses came from the Big Four High Street banks. Meanwhile, 56% of SMEs admitted they were unaware of the alternatives.
Later in the year, a survey of 2,000 adults conducted by hybrid crowdfunding company Crowdfinders found that personal savings, traditional bank finance and friends and family investment were the most popular and well known sources of capital. In contrast, awareness of and enthusiasm for alternative finance was relatively low. For instance, only 8% favoured crowdfunding as a means to raise capital.
The continuing dominance of traditional bank lending is probably not surprising. Banks have long since been the first port of call for small businesses, and the solutions they offer – notably term loans and overdrafts – are well understood. On the other hand, the term ‘Alternative finance’ is a catch-all for a broad range of funding solutions that include not only platform based lending and crowdfunding but also invoice finance and asset based finance. And as the number of finance providers continues to proliferate, the challenge for a small business owner is to keep abreast of developments; this isn’t an easy task, and some may feel more comfortable sticking with a familiar bank model. There are a few reasons, however, for businesses to look past High Street.
The Case for Awareness
Traditional banks remain the most important source of finance, and their lending to SMEs did pick up towards the end of 2016. But bank support is not guaranteed, even for long-standing customers, so a business that needs to access capital to fund growth may be better served by alternative providers. A failure to explore all the options could result in businesses missing out on finance they need. Equally important, by researching the market, businesses put themselves in better a position to access the most appropriate solutions in terms of their requirements at a particular time.
Weighing the Alternatives
In practical terms, that means not only looking at the attributes of a particular form of funding – say crowdfunding or peer-to-peer lending – but also the variations on the concept offered by individual solutions providers.
For instance, an early stage company that needs to raise cash to develop a product might consider either ‘rewards’ or ‘equity crowdfunding.’ Both provide a means to raise money, but have different strengths and offerings.
Rewards crowdfunding does not involve any transfer of equity. Those who commit cash do so in return for a reward – usually in the form of a finished product. As such, it’s an ideal way to pre-fund a project, leaving the director with control and ownership. Equally important it provides a means to validate a concept. If you can attract cash, then it is a sign the product has legs.
Equity crowdfunding can also be used to raise the profile of a business concept or product. Equally it can be used to source the capital necessary to take an existing product to the market. The big difference is that cash is exchanged for a stake in the company. This can have real benefits. ‘Fans’ of the company become longer-term investors. With perhaps hundreds or even thousands of crowd investors, the business has an army of ambassadors with a real financial interest in success.
But equity crowdfunding has many faces. Some platforms specialise in sectors (green energy or social enterprise) while others have a bias towards companies at certain stages of development. Most have a minimum investment. A high threshold will limit investment to relatively well-off investors. Some platforms provide a hybrid of angel, VC and crowd investment.
It is therefore important for SMEs to assess the funding options that work best for them, and to fully understand the business model of the funding platform that they hope to use.
The same is true of platforms matching lenders with businesses. The advantage of a debt platform is that investors are not looking for stellar growth prospects in order to see a return. Their focus is on the company’s ability to meet the repayment schedule. In that respect, lending platforms are ideal for businesses that are generating revenues and have capital requirements that are not necessarily linked to a fast-growth plan (although they can be). Furthermore, debt financing is a good solution for those who don’t want to surrender equity.
Of course, there are other factors to consider. These include the sums of money available through individual platforms, the nature of the due diligence programme, the collateral required and the average time spent processing an application.
The profile of lenders is also a factor. Some peer-to-peer sites are open to all types of investors, and others – including The Route –Finance’s Private Debt Platform (PDP) – draws investors from a smaller community of High Net Worth Individuals (HNW’s). As such, it’s important to look at the investor profile. For instance, it’s arguable that High Net Worth Individuals may be prepared to provide higher sums than a more general cross section of the population. They may also have different risk appetites. This will vary from platform to platform, so it’s worth researching a record of each investor community in terms of sums typically raised and the types of project they tend to back.
Moving beyond the platforms, businesses that offer credit to customers might consider invoice finance as a means to manage cash flow. Those with valuable assets can unlock large sums from Asset Based Lenders.
The key is research. To that end, The Route –Finance has published a guide to the options available. It is available for download here
For those new to alternative finance, whether brokers or SMEs, the guide provides a helpful overview in understanding the different types of alternative finance available, and some assistance in identifying the providers best suited to specific funding requirements.